Wednesday, October 31, 2007

The last two quarters are the strongest GDP in four years—just about 4 percent real growth. Consumer incomes are 4 percent ahead of last year, after taxes, after inflation.

The booming export sector has cancelled out the recessionary housing sector. The economy is speeding up. The jobs numbers we got from ADP today suggest that we could get 125,000, maybe 150,000 jobs on Friday. That’s post-August, post-credit crunch, post-pessimism, post-doom-and-gloom, and post-bearishness.

Look, I’m not saying we’re going to get 4 percent growth for the next four quarters. I acknowledge the housing recession. I acknowledge a lot more price-cutting is going to go on. I acknowledge pockets of credit freeze in the banking system and financial markets. But I also want to acknowledge the fact that a low-tax rate, low-inflation rate, low-interest rate economy is performing superbly. It’s shown itself to be extremely resilient. And that’s why the stock market has done so well this autumn.

I wish somebody would give this economy—the greatest-story-never-told—just a little credit. The fact is that stock prices are hovering near record highs, inflation is coming down, growth is going up, and jobs are going up.

We can forecast until we’re all blue in the face. But the reality is that the economy looks a lot better than the prognosticators suggest.

*Wayne Angell, former Federal Reserve Governor*Bill Heller, former Federal Reserve Governor *John Taylor, Stanford University economics professor & former Under Secretary of the Treasury for International Affairs

MAKING SENSE OF IT ALL...Our panel will discuss all the latest news and developments affecting the dollar, inflation, gold, oil, and more.

If you take out financials and consumer cyclicals, you’re left with a 13 percent increase in the other eight sectors of the S&P 500. In other words, while housing & subprime are weak and remain a problem, the rest of the economy and the rest of earnings are doing great.

We had a dynamite oil discussion on last night’s Kudlow & Company. My take on the price of oil is that it’s largely being determined by the strength of the global economic boom. It’s about the global spread of capitalism throughout China, India, Eastern Europe, and everyplace else.

Incidentally, higher priced oil doesn’t pack the same punch as it used to.

Check out the following chart.Isn't that wonderful? What it shows is that the use of oil per GDP unit is down 50 percent since World War II. Around 1950, energy consumption was just under 20 percent. Then around 1980, it had fallen to around 15 percent. Nowadays, it’s down under 9 percent. This is good news. So why’s everyone hyperventilating about oil? Why’s everyone so pessimistic?

Here are some additional thoughts from a couple of my guests.

DAN YERGIN (chairman of Cambridge Energy Research Associates): [The price of oil] is decoupled from the fundamentals of supply and demand. What’s driving the oil price now is the cauldron of geopolitics, momentum and financial markets, and tying it all together, fear, combined with a weakening dollar. So we could be one or two events away from $100 a barrel oil. So events could put it there. But if you look at it in terms of supply and demand, it’s not as connected as it was in the past…I think the way it’s going now, some other events, some more intensification—we’re just six dollars away from $100, we can get there. But you know…economics work. And at some point, the price will respond to it, particularly when it’s disconnected from fundamentals.

BOB HORMATS (Vice Chairman of Goldman Sachs International): I think [the price of oil] is out of line with the fundamentals, let me address that first. Oil is not just an economic commodity, it’s a political commodity. And every time you get a lot of fear in a region that produces a lot of oil, even if it’s not directly related to that oil supply, even if it’s around that area, it does tend to push prices up. And we shouldn’t forget the fact that there’s an increasing escalation of pressure on Iran. That doesn’t mean the [United States] is going to move against Iran, but the markets look at this and they don’t want to get caught flat-footed if in fact that were to occur. I don’t think either of those things are going to happen in the near-term. I do think that the price is out of line with fundamentals. But as long as these political risks are perceived in the market, [the price of oil] is going to be high…I think the next move is going to be up because there are so many political uncertainties in the oil producing parts of the world. It’s hard to see it going down. Economically, it would go down, but the geopolitics of oil are going to keep it up higher.

Monday, October 29, 2007

(Please note that CNBC's Kudlow & Company has moved to its new 7pm ET time slot.)

***THE OIL STORY, EMERGING MARKETS & MORE

On to discuss:

*Bob Hormats, Vice Chairman of Goldman Sachs International*Dan Yergin, chairman of Cambridge Energy Research Associates*Ken Timmerman, Executive Director of the Foundation for Democracy in Iran, and author of "Countdown to Crisis: the Coming Nuclear Showdown with Iran."

FED & THE ECONOMY...Our panel will take a look at the latest economic news and offer their take on what lies ahead in this week's Fed meeting.

House Ways and Means Chairman Charlie Rangel’s “mother of all tax reforms” has some very serious flaws. My supply-side friends have been trashing his plan mercilessly since its unveiling late last week. And as I told Mr. Rangel, when I interviewed him last Thursday night on Kudlow & Company, raising the top tax rates on America’s most successful earners and investors is not a good idea. It’s a surefire way to damage U.S. competitiveness. It will also reduce our potential to grow (not only long-term, but in the short run, as the economy is softening.)

Still, I come to praise Mr. Rangel, not to bury him.

Charlie Rangel is the first Democrat in Washington, or on the campaign trail for that matter, to propose a pro-growth tax cut, namely a reduction in the corporate tax rate. No democrat has gone there before. That’s big stuff. It means something. Democratic leaders are backing away from Mr. Rangel due to their unwillingness to propose pro-growth tax cuts and their obsession with punishing the rich. The last pro-growth democrat to propose lower tax rates was the late President John F. Kennedy. He lowered taxes across the board for all individuals and companies. Might Charlie Rangel be part of the JFK tradition?

Supply-siders have long believed that tax reform should broaden the base by eliminating complex credits, deductions, subsidies, and tax expenditures, while at the same time reducing high marginal tax rates that impair economic growth and incentives. Right now, the most punitive high marginal tax rate under current law is the 35 percent corporate tax rate. It’s been a drag on growth and worker wages.

Incidentally, in an earlier conversation with Mr. Rangel, he told me that Treasury man Henry Paulson had convinced him of the need to reform the anti-competitive corporate tax. That tells me that Charlie Rangel is open to an important pro-growth tax reform. In that spirit, I believe Mr. Rangel deserves be treated in a more kindly and hospitable manner by my fellow supply-siders. Charlie is someone we can work with. We can do business with him.

I remember years ago, back in the early 1990s, when Charlie worked with Jack Kemp to lower the capital gains tax. This was done not only as a means of improving the sluggish economy (following the commercial real estate credit crunch), but also as a way of providing more capital to African-American neighborhoods, businesses, and entrepreneurs where the lack of outside capital choked off economic growth and prevented blacks from climbing the ladder of opportunity. Mr. Rangel’s willingness to buck his party and consider a lower capital gains tax is another reason why I believe the House’s top taxman deserves just a little more praise, and a little less criticism, than he’s been getting from my brethren.

And by the way, where are the republicans on full-scale tax reform? What we need right now is for the White House to respond to Mr. Rangel with a full-fledged tax reform plan of its own. The Bush administration had a tax reform panel in 2005 led by former Senators Connie Mack and John Breaux. And while the results of that panel were far from perfect, it could potentially constitute an important talking point in a conversation with Mr. Rangel. We need to add oxygen to the tax reform conversation, not smother it.

We also need to hear from the Republican presidential candidates on their ideas for full-scale tax reform. Let’s get specific, fellas. So far, the only candidate who has proposed anything of substance is former Arkansas Governor Mike Huckabee with his national sales tax idea called the Fair Tax. While the other GOP frontrunners have pledged to maintain President Bush’s tax cuts that expire in 2010 (obviously a good idea), so far they have not proposed any specific, far-reaching new tax reform plans. The time has come gentlemen.

If the White House weighed in, and if the Republican candidates weighed in, and if the conversation with Mr. Rangel were expanded and nurtured, rather than stymied and steamrolled, that would leave the Democratic congressional leadership and their presidential candidates as the odd person out. That creates a political opportunity.

We need to encourage tax reform by maintaining an open, friendly conversation with Mr. Rangel and nurturing additional, specific, tax reform ideas from GOP leaders. Just as I’ve always preferred optimism to pessimism, and positives to negatives, I also prefer friendly discussions to holier-than-thou trashings. Let’s work with Charlie.

Friday, October 26, 2007

(Please note that CNBC's Kudlow & Company has moved to its new 7pm ET time slot.)

Well, we've got a dynamite show lined up tonight.

***Indefatigable Renaissance man Ben Stein will join me at the top of the show. He'll offer his take on the stock market, economy, and the benefits of taking a long-term approach to investing. Ben will stick around for the whole show.

***Also on tap: my exclusive interview with Vice President Dick Cheney. We covered a lot of ground during the interview earlier today. Topics include Iran, oil, the economy, Rangel's tax reform plan, and GOP prospects in the upcoming election.

***Last, but certainly not least, we'll have the Dynamic Duo with us this evening. The Wall Street Journal's Steve Moore will battle it out with former Clinton Labor man/public policy professor at the University of California at Berkeley, Robert Reich.

It's going to be another great show tonight. Please be sure to join us at 7pm ET on CNBC.

And yes, we still believe that free market capitalism is the best path to prosperity...

I’m down in D.C. where I just wrapped up a one-on-one interview with Vice President Cheney. The full interview will be aired on Kudlow & Company at 7pm ET.

We started off by talking about what seems to be on everyone’s mind of late—oil. I asked the Vice-President about the White House’s stiffer financial sanctions on Iran, and whether this might lead to a boycott or stoppage of Iranian oil exports. He left that door open. He didn’t want to speculate, but he did leave the clear impression that if it leads to that, so be it. I followed up by asking whether the Strategic Petroleum Reserve could come into play. He said only in the event that there were oil disruptions. We also talked about what price oil could potentially affect the economy.

We discussed Charlie Rangel’s new “mother of all tax reform” bill, as well as Hillary Clinton’s “trap-door” campaign message that the middle class is being squeezed. (He was not keen on either.)

Overall, Mr. Cheney seemed rather optimistic and upbeat about the state of the U.S. economy.

Please join us on CNBC tonight at 7pm ET to catch the entire interview.

Thursday, October 25, 2007

I have tremendous respect for House Ways and Means Chairman Charlie Rangel. And I take my hat off and give him a lot of credit for what he’s done in a tough political environment. He’s done what he can and his heart is in the right place on all this. That said, while it seems to me that he wants to recreate a sort of 1986 Reagan/Rostenkowski tax reform moment, I’m not sure he’s going to get there.

Here are some highlights from my interview with Mr. Rangel. The full interview will air tonight at 7pm ET on Kudlow & Company.

Basically, the top earners are going to see a big tax hike from 35 to 44 percent. Capital gains taxes are going to go up. Small business taxes are going to go up. And large corporate taxes would go down under this plan.

Among the many issues I raised with Mr. Rangel during our interview is that we are experiencing a slowdown in the economy. Wall Street and Main Street are worried about recession. Is this the right time to be talking tax hikes for anyone? (I think not, but then again, I don’t run the Ways and Means Committee.)

Mr. Rangel talks about raising taxes on a million people and giving everybody else a tax break. But technically, if you exempt someone from the alternative minimum tax, that’s really not a tax cut since the AMT wasn’t supposed to hit them in the first place.

And he doesn’t deal with the impact on small businesses. Small businesses add serious firepower to our economy. They are our biggest job creators. So going from 35 percent to 44 would be rather punitive.

Another problem I have with this plan is the issue of competitiveness. Look, foreign countries are in fierce competition with us. If we head in the wrong direction on taxes, we’re going to risk serious movement of capital and investment away from the United States.

There is another option. Over in the House, Republicans Paul Ryan (WI), Jeb Hensarling (TX), and others also want full-scale reform. They want to eliminate the AMT. They want full-scale tax reform and simplification. Their plan consists of two rates—10 percent and 25 percent—and abolishing virtually all of the other so-called loopholes.

Last night I interviewed Bruce Marks, CEO of the Neighborhood Assistance Corporation of America (NACA) about his plans to work with Countrywide to help distressed homeowners restructure their mortgages and keep a roof over their heads.

I wish Bruce great success in his endeavor. I think what they’re doing with Countrywide is a great project.

All these various ideas circulating to help working Americans with steady incomes keep their homes, keep a roof over their family’s heads, and avoid foreclosure are in my opinion, terrific. It’s old-fashioned banking. I say let’s do it. It’s the American way. It’s the capitalist way. I wholeheartedly endorse all of it.

As my guest Jim LaCamp, portfolio manager at RBC Dain Rauscher said, “If it works better for [Countrywide] then great…The banks don’t want the houses, the borrowers do want the houses, and the investors don’t want complete default—they’d rather have something back than nothing. This is a better solution.”

LaCamp’s right. Our country is not helped if all these neighborhoods are wrecked because people couldn’t meet some payments. If they’re working people, and they have income, let’s try to help them work through this period.

Free market capitalism can be compassionate. Borrowers and lenders can both win here.

House Ways and Means Committee Chairman Charlie Rangel, (D-NY) will discuss his new "Mother of All Tax Reform" plan in an exclusive one-on-one interview on this evening's program. You won't want to miss it.

HOUSING & THE FED...Former Federal Reserve Governor Wayne Angell will join us to lend his insight on today's housing number and next week's Fed meeting. Our market panel will weigh in with their perspective.

Former Federal Reserve Board Governor Wayne Angell has consistently argued for a worse than expected U.S. housing slump accompanied by larger than expected price declines. Well, today's record drop in existing home sales with a bulging 10-½ month ratio of unwanted homes on the shelf, and a 4 percent median price drop in September confirm Wayne's view.

While chief economist over at Bear Stearns, Wayne had a good interest rate forecasting track record. So it's important to note that he's calling for a 3 ½ percent to 4 percent fed funds rate, down from its present 4-¾ level.

The Fed will announce its next policy directive on October 31st, a week from today. Bond markets have fully discounted a 25 basis point cut in their target rate. I'm wondering if they shouldn't do another 50 bps, a second shock and awe action?

This would be a pro-growth economic signal for a 2008 rebound that might conceivably boost the dollar. It would also help fragile credit markets. Bears will argue against rate cuts because they worry about inflation. But it's hard to find any continuous inflationary evidence.

Oil, gold, and other commodity price increases seem to be part of the global boom story, not the inflation story. In the inflationary 1970s, rising commodities were associated with falling stocks. In the 2000s, rising commodities are now associated with rising stocks.

It could be that investors want the U.S. to get its rate cuts out of the way, quickly, in order to better share in the global boom. Any excess liquidity would be absorbed by rising investment.

Meanwhile, House Taxman Charlie Rangel's plan is scheduled to be released tomorrow (I will interview him on Kudlow & Company). It looks like it will raise personal taxes while reducing corporate tax rates. It's too bad that Chairman Rangel didn't opt for a big bang Reagan/Rostenkowski 1986 tax reform moment. The best approach would have been to cut all tax rates and broaden the tax base by getting rid of all the special interest flotsam and jetsam and corporate welfare subsidies. That approach would boost the dollar and growth.

Ultimately, I think Mr. Rangel's hands are tied by a Democratic House Caucus bent on class-warfare. I still think the "inner Rangel" has a lot of supply-side blood in him. Whatever the case, very little of his tax package is likely to make it into law.

I still think that investing in stocks for the long run is the way to go. On the whole, it’s a far better strategy than short-term trading. Why not own a bunch of index funds that are diversified? You can get this stuff cheap. They’re liquid, tradable, and relatively inexpensive.

Take a look at this great chart going back to 1980.

Look at the unbelievable performance over the last quarter century. In fact, had you bought the Dow just after Black October of 1987, you’d be up around 680 percent today.

My friend Ben Stein has been hammering this home recently. He wrote a great piece in The New York Times two Sundays ago about this very point. Ben is dead right. (Incidentally, Ben will be sharing his unique perspective with us on Kudlow & Company Friday night.)

Last night I asked Jeremy Siegel, Wharton Finance professor and author of “Stocks for the Long Run,” the following question: Who does better, long-term investors or traders? That’s really the key question. Siegel said it’s a no-brainer—definitely long term investors. He conceded that there’s a very tiny few who can buck the trend and succeed in the short term game. But on the whole, it’s no contest, you want to be a long-term investor.

I posed the same question to Trend Macro CIO Don Luskin. Here’s what he had to say: “There’s no question about it. The great myth of trading is that it’s the very, very few survivors in the trading game who show their face to the public, who come on CNBC. What you don’t see…are [the] 10,000 who are driving cabs and flipping burgers somewhere.”

It's quite simple actually. If you want to fatten your wallet, and if you want to sleep better at night, then you need to own a piece of the American rock. Own it for the long run. Our dynamic system of free market capitalism works. It’s still the safest, surest, most profitable investment strategy out there.

POLITICAL DEBATE...Our panel will take a look at last night's GOP debate, Hillary & Obama, and much more.

On board:

*John Fund, Wall Street Journal columnist *Larry Sabato, director of the Center for Politics at the University of Virginia*"Jimmy P" Pethokoukis, senior writer at U.S. News & World Report*Cornell Belcher, Obama pollster, founder of Brilliant Corners Research and Strategies

THE MOTHER OF ALL TAX REFORM?...On to debate what lies ahead with taxes are tax experts Heather Bennett and Mark Heesen.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Ben Stein penned another very good column this weekend. It struck an appropriately optimistic and bullish tone for the stock market and economy.

Ben’s also right about some very bad bets made by the big banks. I certainly hope that taxpayers won’t wind up picking up the tab for this stuff. (Incidentally, I thought everybody agreed after Enron that off-balance sheet stuff was strictly verboten. Is the Paulson Treasury now condoning off-balance sheet activity? If they are, they’re dead wrong.)

Transparency means putting everything on the balance sheet for investors to see clearly. A big reason investors won’t go near subprime loans of any kind is because they don’t know exactly what the loans are. They don’t know what’s inside the so-called conduits and what sort of pricing is involved.

Just like the homebuilders, banks have got to slash prices. They need to take the hit to get rid of their unwanted inventories. The sooner the better.

Spirits were high with a lot of good sound bites at the GOP debate last night. Attacking Hillary is great fun. And I guess attacking each other is the new sport. But there wasn’t much economic policy content.

I didn’t hear anything about what the candidates would do if the economy succumbs to recession. Nor did I hear anything about the subprime credit crunch, or how to help middle or lower middle income working folks who are threatened with mortgages they can’t afford. There are a lot of Reagan Democrats and Perot Independents in this group.

There were stirrings of an interesting Social Security debate, but there were no specific references to balancing the budget and solving long-term fiscal problems.

I still believe the candidates have to be morespecific, particularly with the Ross Perot independent voters that walked away from the GOP last November. And I still don’t hear them reaching out to the investor class. This is a core GOP constituency shunned by Hillary.

Surprisingly, I didn’t hear much about pro-growth tax reform. Mike Huckabee and Duncan Hunter did briefly talk about jobs and wage inequality—but both with a protectionist trade tilt that is troubling.

Hillary’s running an ad in Iowa and New Hampshire entitled, “Trap Door,” stoking middle class anxieties on wages and healthcare. Rebuilding the middle class is her theme. She’s saying that widening income inequality has reached levels not seen since 1929, and that typical taxpayers have found their real income drop 2 percent between 2000 and 2005. Nonsense. This 1929 stuff is right out of Bill Clinton’s 1992 campaign playbook. And it’s just as ludicrous today as it was fifteen years ago. But Hillary is striking a raw nerve.

The GOP needs to rebut the phony statistics and respond to middle class anxiety. I do think part of Mike Huckabee’s rise in the polls can be attributed to him talking about this stuff, but so far I don’t like his solutions. They sound a lot like protectionism. His national sales tax, which he didn’t mention last night, is intriguing, though I am not persuaded. I still favor flat tax reform that would collapse and reduce middle income tax brackets to around 15 percent.

So, while I applaud the energy and wit on display during last night’s debate, I’m not sure the Republican candidates are making the sale. National Review's Byron York is absolutely right, the GOP race is wide open.

Friday, October 19, 2007

Sometime in the latter half of the 1990s I coined the phrase “King Dollar.” This was back in the post-Soviet collapse period when the U.S. greenback ruled the world currency roost. As the Berlin Wall came down, taking totalitarian socialism with it, global investors and businesses sought the U.S. dollar as their currency of choice. They also chose the American model of free-market capitalism — including supply-side reductions in marginal tax rates — as their economic reform of choice.

The result was the greatest world economic boom in the history of history.

From Eastern Europe to India and China, and points in between, the world has experienced an unprecedented prosperity boom, a story best captured by the unbelievable rise in global stock markets. But along the way, as the world moved toward growth economics and away from central planning, King Dollar began to slide. Not because the U.S. was faltering (as the doom-and-gloom pessimists see it), but more because the rest of the world has been doing better. In other words, the dollar hasn’t slumped because it is necessarily weak, but because the new euro and new market economies are so strong....

Former Federal Reserve Governor Wayne Angell will join us to discuss the credit crunch, economy, Fed, and the dollar.

THE ECONOMY, KING DOLLAR, & THE MOTHER OF ALL TAX REFORM

On to discuss:

*"Jimmy P" Pethokoukis, senior writer at U.S. News & World Report*Art Laffer, chairman of Laffer Associates*Steve Moore, member of The Wall Street Journal editorial board*Ted Truman, former director of the Federal Reserve's international staff, and former Assistant Secretary of the Treasury

CNBC's Steve Liesman will rejoin the show with the Q & A portion of Secretary Paulson's speech. Our economic panel will weigh in with their response.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

“The reality is the federal government would not lose any money if it cut the corporate tax rate by 5 or 10 percent. We’ve seen over the last decade these dramatic [corporate] tax rate cuts in Europe. The average rate there now is at 24 percent. Corporate tax revenues as a share of GDP in Europe have soared since the 1980s. We’re on the far side of the Laffer Curve.” –Cato tax expert Chris Edwards on last night's Kudlow & Company discussing Rep. Charlie Rangel’s "mother of all tax reforms" and reports that Rangel might be considering cutting the corporate tax rate from a sky high 35 percent down to 25 percent.

WASHINGTON TO WALL STREET DEBATE...On to duke it out over all the latest from Washington are Leonard Burman, Senior Fellow at the Urban Institute and Chris Edwards, tax director at the Cato Institute and author of Downsizing the Federal Government.

IRAN & RUSSIA...Sen. Richard Lugar (R-IN), ranking member of the Senate Foreign Relations Committee, will weigh in with his perspective.

TACKLING GLOBAL TERRORISM & A NUCLEAR AL QAEDA...On to discuss the unthinkable are Dan Yergin, chairman of Cambridge Energy Research Associates; Frank Gaffney, president of the Center for Security Policy; and Steve Emerson, NBC terrorism analyst and author of Jihad Incorporated: A Guide to Militant Islam in the US.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

"The real mystery about this Morgan Stanley sale of The New York Times stock today—the thing I don’t understand—is who was stupid enough to buy it from them?" -Don Luskin, Trend Macro Chief Investment Officer on last night's Kudlow & Company

OSLO, Norway -- Former U.S. Vice President Al Gore said winning the Nobel Peace Prize hadn't pushed him to enter the 2008 presidential race.

"I don't have plans to be a candidate again, so I don't really see it in that context at all," Mr. Gore told Norwegian state broadcaster NRK in an interview broadcast Wednesday. "I'm involved in a different kind of campaign. It's a global campaign. It's a campaign to change the way people think about the climate crisis." NRK said it interviewed Gore in Nashville, Tenn.

At a news conference last Friday in Palo Alto, Calif., Mr. Gore sidestepped the issue of a presidential run, saying then that he wanted to "get back to business" on "a planetary emergency."

Mr. Gore, who shared the Nobel Prize with the United Nations' Intergovernmental Panel on Climate Change, told NRK that it was a "great honor" to win the peace prize. "For me personally it means the chance to be more effective in trying to deliver this message about the climate crisis and the urgency of solving the climate crisis," he said.

On Tuesday, a Gallup Poll found that there was no surge in support for Mr. Gore to run for office. Asked if they would like to see Mr. Gore run for president in 2008, people said no by a margin of 54% to 41%, according to the Gallup Poll, about the same as in March, when people opposed his running by 57% to 38%.

Even among Democrats there was no visible surge of interest in Mr. Gore. In the new survey, 48% of them said they would like him to run and 43% said they would not. In March, Democrats were in favor of his entering the race by 54% to 41%.

GOP SHOWDOWN...Pollster Scott Rassmussen, president of Rasmussen Reports will lend his insights on all the latest campaign news including recent in-fighting among the GOP candidates. Messrs. Reich & Moore will join in.

Please join us at 7pm ET on CNBC for another free market edition of Kudlow & Company.

Actually, high oil prices can be very bullish. Note that global stock indexes have been rising in sync with higher oil prices. This probably means that the rising price of oil is a function of the global economic boom, where oil demands are outstripping oil supplies. So all the gloom and doom scare talk is wrong.

It’s a completely different story than the 1970s. Back then, oil supplies were cut off, while heavy-handed government regulatory controls interfered with the free flow of oil. So it’s time to think again about high oil. High oil can be quite bullish.

Monday, October 15, 2007

It looks like investors woke up this morning and puked when they read the front-page stories about big banks pooling together to create liquidity backup for subprime mortgage paper and other loans.

The major stock indexes are off a percent. But the biggest losers were the financials which were down almost 2 percent. Among that group, the hardest hit were Citi, Lehman, Merrill, Bear, Goldman, Washington Mutual, Freddie Mac, and Countrywide.

The ABX BBB minus index of subprime paper fell four dollars from $29 bucks to $25 bucks. Incidentally, that index stood at a hundred on January 1st.

Now let me get this right. Here’s my reading. At the urging of the Treasury, the big banks that couldn’t sell asset-backed commercial paper, have decided to pool their resources and create a new vehicle to do what? Sell more asset-backed commercial paper. The markets aren’t buying it. They gave it a big Bronx cheer.

There’s something like $500 billion dollars worth of asset-backed commercial paper to be rolled over in the next few months. And, while no one can be sure, there’s something like $500 billion dollars worth of subprime securitized mortgage bonds, plus leveraged loans from various buyouts and the private equity deals that are sitting on bank shelves.

Eventually this paper will be sold at big discounts. Now the banks will take big haircuts, cutting into their loan loss provisions, and their capital adequacy ratios. That, in turn, may reduce the availability of loans to money good businesses and consumers.

In other words, the subprime credit crunch has additional shoes to fall. While it’s quite true that jobs and incomes look pretty good, it is also true that credit turmoil is not yet over.

$100 OIL?...On to discuss the future of energy prices will be Dan Yergin, chairman of Cambridge Energy Research Associates. Our market panel will also weigh in with their take.

A LOOK AT THE FED...Joining us are Bob McTeer, former President of the Federal Reserve Bank of Dallas; John Taylor, Stanford University economics professor & former Under Secretary of the Treasury for International Affairs; and The Wall Street Journal's Steve Moore.

INTERVIEW WITH SEN. JOHN EDWARDS...The Democratic presidential candidate will join us in a one-on-one interview.

Our market panel, along with Steve Moore will stick around for the balance of the show to discuss Bernanke's speech, markets, and the Edwards interview.

We hope you'll join us tonight at 7pm ET on CNBC for another free market edition of Kudlow & Company.

I really liked Ben Stein’s NYT column yesterday that emphasized the theme of investing in stocks for the long run. It’s wallet-fattening advice.

Essentially, you’re betting on the long run economic future of this great country. You’re buying into our dynamic system of free market capitalism. This is especially true ever since Ronald Reagan reinvigorated US capitalism with supply-side reductions in marginal tax rates, industry deregulation, free trade, and low-inflation targeting by the Fed.

Democratic threats to raise taxes are likely to nibble around the edges. This was the case in the early 1990’s under Papa Bush and Clinton. Still, nobody in their right mind wants to go back to 50 percent or 70 percent tax rates. But there will be other battles, including free trade.

It is inconceivable to me that while the rest of the world eagerly embraces American economic values of freedom and entrepreneurship, that the United States would actually turn its back on these critical core values. That's craziness. And if the Democrats try to spike up tax rates, or tariffs, they will be thrown out of office as was the case with the successful Gingrich rebellion of 1994.

Incidentally, if you had stepped up to the plate and bought stock twenty years ago, after the October 1987 Black Monday, you would’ve been blessed with fabulous returns. 12 percent a year including dividends. It’s yet one more shining example of why investing for the long run is the way to go.

So what I’m saying is that owning a piece of the American rock, via stocks, is still the safest, surest, and most profitable investment strategy out there. Free market capitalism works. Ben Stein has it exactly right.

We’ll be broadcasting live tonight at 7pm during Ben Bernanke’s speech at the Economics Club of New York. Everybody will be looking for Fed interest rate clues. That said, I doubt the Fed chair will offer much in the way of new guidance.

In any event, I don’t think the Fed needs to make any more interest rate cutting moves, at least for the foreseeable future. Their shock and awe, confidence boosting, 50 bps rate cut on September 18th has done a good job. It has loosened up the credit crunch, steered the financial system back towards normalcy, and supported the economy with only about 2 percent inflation.

Of course, we are not out of the woods on the credit side yet. Gun-shy investors are still reluctant to invest in asset-backed commercial paper, subprime mortgage loans, or private equity buyout leveraged loans. That’s why banks are moving toward some sort of safety net pool of liquidity to reduce their loan exposure. This will take time.

But the positive stock market message clearly points to a Goldilocks soft landing economy. 3rd quarter GDP could actually come in close to 3 percent, after a 3.8 percent tally in Q2.

Meanwhile, the soft dollar, rising gold, and message of commodities (including oil) strongly suggest that the Fed ought to protect the dollar. Dollar protection is a good theme for the central bank right now. Therefore, unless something turns really sour, I say the Fed should hold its fire on future rate cuts.

My old pal Ben Elliot sent me a great link to NRO’s Military Blog this morning. Much of the mainstream media would like to keep it contained, but it looks like things are continuing to get better in Iraq. Even the Washington Post conceded this weekend that “there isn’t much room for debate” that violence has dropped in Iraq, and that the Petraeus surge is working.

* * * * * * *

Bill Kristol is right. Republicans are way too gloomy. There’s still a lot of time on the clock, and a lot of things working in the GOP’s favor. The Dems' high tax/high spend/Walter Mondale economic approach is still the GOP’s secret weapon. Check out Kristol's piece over at The Weekly Standard.

I’m surprised that today’s Wall Street Journalstory on income inequality failed to mention that while the wealthiest 1 percent of Americans earned 21.2 percent of all incomes in 2005, they now pay nearly 40 percent of all taxes.

In 1980, before the Reagan supply-side tax cut revolution was launched, the top 1 percent earned 8.5 percent of all income and paid 19.1 percent of all taxes. So while the rich are getting richer, the rich are also paying the lion’s share of the taxes.

As others have pointed out, the top 5 percent of income earners pay 60 percent of the taxes. The top 25 percent pay 86 percent of taxes. And the top 50 percent pay 97 percent of all taxes.

My problem with global warming is not Algore. He’s worked hard. But frankly, I don’t think he should be awarded the Peace Prize. If Gore's climate change work is truly meritorious, he should have been placed in one of the scientific categories.

In a broader sense, the issue for me boils down to:

a) Whether in fact global warming is a manmade problem; b) With so many dissenters, does this viewpoint really pass scientific muster? c) In the history of history I have always believed that men and women are part of the solution, not the problem; d) Nearly all policies associated with global warming “solutions” are inimical to economic growth, prosperity, and progress.

Think of it this way: In the “cap” of “cap and trade”, that “cap” can literally prevent economies from powering forward. In other words, growth requires power, and caps could set back both. That really troubles me.

In addition, all the “solutions” have a heavy governmental footprint. It smacks of central planning. It is the opposite of the economic freedom and free market capitalism that has shown us the path to prosperity. I don’t want limits to growth and I don’t want central planning. Instead, I want entrepreneurship and freedom and Schumpeterian gales of creative destruction.

So, if there is a true climate change problem, I do not want an economy-retarding solution. That would be far worse than the so-called problem.

Attention all shoppers: Stocks are at an all-time high. Goldilocks lives. The economy could grow by 3 percent in Q3 after growing nearly 4 percent in Q2. Moreover, a highly competitive America is exporting at a 13 percent annual rate, including a 24 percent export gain to China, a 25 percent increase to South America, and a 15 percent export rise to Europe.

And even spending in 2007 was held to 2.8 percent growth with domestic spending less entitlement and security actually falling by nearly 6 percent from last year.

So I’d like to thank all you pessimists out there. Your wall of worry is actually driving stocks higher. You have been completely wrong. To quote former Senator Fred Thompson (who quoted me during the Republican debate), it’s still “the greatest story never told.”

So...will ALGORE need to make room on his mantel (next to his Oscar & Emmy) for a Nobel Peace Prize? We’ll find out tomorrow. (Incidentally, do they have a Nobel Science Fiction category?) In the meantime, make sure to check out Iain Murray’s revealing piece over at NRO’s Planet Gore. Kudos to the British legal system…

* * * * * * *

Hats off to supply-side Congressman Paul Ryan of Wisconsin for his bold new tax plan that has annual earnings up to $100,000 taxed at 10 percent with a 25 percent rate on everything else. The plan would also repeal the AMT, and perhaps replace Charlie Rangel’s trillion-dollar tax plan. I’m not sure the country can survive the Democratic plan. Ryan has a much better idea.

Hillary Clinton told the Boston Globe today, "I have a million ideas. The country can't afford them all." She's on to something. Right now she's got $724 billion dollars of new proposals...Check out the Hillary Clinton Spend-O-Meter for more.

Wednesday, October 10, 2007

Last night’s GOP debate featured strong, pro-growth, supply-side policies from the four major candidates—Rudy, Romney, McCain and Thompson. As Steve Moore reports in today’s Wall Street Journal political diary, Ronald Reagan was actually the big winner because they’re all continuing the Gipper’s revolutionary policy transformation.

This is all good. But let me remind folks that yesterday I suggested that Republicans were put on this planet to cut spending and taxes. And the proof of the pudding is in the eating. In other words, we need specifics. In other words, where’s the beef?

Aside from a few exceptions last night, there really wasn’t much beef.

Sam Brownback did propose an optional flat tax. And Gov. Huckabee is staying with his fair tax/national sales tax. But none of the big four are touting these ideas. Outside the debate, Sen. McCain has said that he would be interested in either simplification proposal. But none of the candidates offered any real specifics on spending cut proposals.

National Review’s Byron York (one of the best political reporters in the game) is not expecting any specifics on that front. That’s too bad. Voters want to hear more on this subject. This is the year to be specific.

Former Sen. Fred Thompson did talk about cutting social security benefits by shifting to a cost of living index from the wage index. But this may actually be the wrong kind of specific. Democrats were already screaming about this on our program (Jared Bernstein) as a big benefit cut. And in fact it is.

I’ve never been enamored with that approach. It would be much better to grow ourselves out of the social security problem with strong supply-side policies for the whole economy. (And yes, I would extend the retirement age gradual over time. But benefit cuts are a real bad idea.) Private savings accounts, which were endorsed by several candidates including McCain, have to be part of a Republican package.

When you look at the non-defense, non-security budget between FY 2001 and FY 2007 -- when the GOP controlled three houses in Washington -- spending rose roughly $550 billion dollars. That’s a whopping 38 percent, or 5.5 percent each year. It’s also more than twice the 2.4 percent inflation rate during that period.

The Education Department was by far the biggest transgressor. It posted an alarming yearly growth of 11.4 percent. Other obvious abusers include the Interior Department, which grew at 5.8 percent, and Transportation, which came in at 4.4 percent. Rounding out the profligate herd was Energy with 5.1 percent; Agriculture at 4.5 percent and HUD at 4.0 percent. Every single one of these government agencies ballooned its budget well beyond than inflation rate.

The Republican Party needs to re-brand itself as fiscal disciplinarians. GOP candidates must get specific about which departments and program clusters they’re going to curtail. The sooner the better. The burden is on their backs to reestablish credibility.

And while the Democrats are making hay with middle class anxieties over taxes, health care, tuition, etc, Republicans need to launch an aggressive middle-class tax offensive.

For example, we don’t need six income tax brackets. Here’s a thought: Take the 33 percent bracket that starts at $188,450 dollars and get rid of it. Ditto for the 28 percent bracket at $123,700 and the 25 percent bracket at $61,300. Get rid of them. Collapse it all down into one simple 15 percent tax bracket. Then figure out what kind of spending cuts are necessary to finance it.

Look, the reality right now is that Republicans need to prove their bona fides all over again. The top four candidates are all solid and strong players. But policy proposals are going to be crucial as Sen. Clinton develops her own detailed plan, along with Sen. Obama and Edwards.

Message to Republicans: No more veggies on spending and taxing. Put some steak on the plate.

From my post-debate interview last night with Sen. John "Backbone" McCain.

KUDLOW: Joining us right now is Senator John McCain, Republican from Arizona. Mr. McCain, some of the distinguished panelists, all hard-bitten partisans up here, are singing your praises about a comeback kid story. What's your response?

SENATOR JOHN MCCAIN: God bless them. Larry, could I say one thing about this line-item veto? My one regret is that I wasn't in that discussion because I wanted to get into it. I was one of the prime sponsors of the line-item veto. It was declared unconstitutional because of the way it was written. It is not unconstitutional in the way we are writing it now. ... The fact is 43 governors have a line-item veto. We've got to have the line-item veto. Ronald Reagan wanted it, everybody wants it, it has got to be done, otherwise we're not going to eliminate these pork barrel projects. You've seen the smoke and mirrors that is going on right now on earmarks. Look, the line-item veto can be and should be constitutional and there's a way to phrase it and there's a way to do it ... we can write it so it's constitutional. It is a vital tool and ... I was one of the prime sponsors of the line item veto when we pas sed it.

KUDLOW: How about on Social Security reform? You made a point in the debate to talk about entitlement reform, I think you said we're basically going broke on these big entitlements. Can you put some beef on that for us? Can you give us a sense of where you go on Social Security?

MCCAIN: Sure Larry, I think everything has got to be on the table. I applaud President Bush's efforts after the 2004 election. He said, look, come and sit down with me, the Democrats said you have to have tax increases on the table we got a little sidetracked on personal savings accounts, which I strongly support. I think [personal savings accounts are] one of the major ways we're going to allow people to realize real retirement benefits. But I really believe you have to have everything on the table, but I'm opposed to tax increases, I don't think you have to do it. I think you can get a study headed by Greenspan or one of those people, and implement it and you have to shame the Democrats ... they wouldn't sit down with us ... to say come and sit with us at the table and we'll fix this -- it's going broke. ... I go around the country with one chart: how much money is coming in, how much is going out. When there's more going out than coming in and there's no money left, and ask the American people if that is what they wanted to do to the next generation of Americans.

Please note that tonight marks the launch of our move to the 7pm ET slot on CNBC. We look forward to bringing you more of our unique, unfettered, Washington to Wall Street perspective on the stock market, economy, and politics in the new hour. Please join us this evening when free market capitalism makes its move to 7pm.

Yours truly will be hosting the post-game show following this afternoon’s GOP debate on CNBC. The actual debate will go from 4-6pm. I’ll take over after that with a special 2-hour edition of Kudlow & Company.

In the first hour we’ll talk with Rudy Giuliani, Mitt Romney, John McCain, Mike Huckabee, and Ron Paul. I’ll be joined by pollster Scott Rasmussen and the “Dynamic Duo” of The Wall Street Journal’s Steve Moore and former labor secretary Robert Reich.

In the second hour, former Virginia Senator George Allen (co-chair of Fred Thompson for President) will offer up some of his thoughts. We’ll also talk with some Democratic presidential hopefuls including New Mexico Governor Bill Richardson and Connecticut Sen. Chris Dodd.

Right now the Romney camp is pointing fingers at the Giuliani camp, which in turn is pointing fingers back at Romney that neither is really a budget cutter. What’s lacking here is exactly which government departments, agencies, or programs can be radically cut back or eliminated all together?

As for solving social security, which of the GOP hopefuls will use private savings accounts? Will they increase the retirement age? Or will they shift from a wage based inflation index or CPI inflation index?

And why aren’t they talking about balanced budget rules that would cap spending totals?

In the spirit of Dick Armey, why not move ahead with a spending pay-go? All that means is that if you go ahead and raise spending in one area, you need to cut spending somewhere else. No tax increases, but rather, spending cuts.

I also want to tackle this issue of middle class discontent, or so-called “economic populism.”

First off, with respect to taxes, why do we need six tax brackets? Right now, the middle-income people have three brackets - a 28 percent, 25 percent, and a 15 percent bracket. Low-income folks have a 10 percent bracket. High-income earners have their 35 and 33 percent brackets. Why not abolish the middle-income brackets and go back to Ronald Reagan’s 28 and 15 percent brackets and get rid of the 10 percent bracket altogether?

Why not a single rate flat tax like Eastern Europe? What about the kiddie credit or the marriage deduction?

In other words, tax ideas should go beyond George Bush and should be very specific, especially supply-side incentives for the middle-class in the form of lower marginal tax rates.

Look, the GOP needs some serious rebranding right now as the party of limited government, both on lower spending and taxing.

So I’ll be on the hunt for specifics tonight – not generalities.

Sen. Hillary Clinton has a whole policy booklet on her ideas. And of course I don’t agree with her. But as for the Republican candidates, where’s their playbook? Where’s the beef?

Here's a kind email sent last night by one of our viewers. I think he's caught the essence of what we're trying to do at Kudlow & Company. Incidentally, we're moving to the 7pm CNBC slot tomorrow night.

Subject: Kudlow's Stock Rises

Kudlow & Co. is moving into prime time, 7 eastern, 4pm west coast time, on CNBC. The reason is a huge increase in ratings. Moreover, Kudlow will anchor the wrap-up of the Republican debate tomorrow night. The increase in viewership is not surprising given the wide ranging subjects he covers and the intellectual pro and con debates that occur.

I am not a supply-sider, and I disagree with Kudlow on some issues, and his cheerleading and references to "good Americans" makes me squirm at times, but the caliber of guests that he attracts is absolutely stellar.

The niche he has developed in the market is attracting some of the top people in the country. And from what I hear the top people in the country are tuning in as a must see. It gives us all a chance to hear views, both pro and con on subjects that need airing - that usually aren't - and in depth.

Kudlow is admittedly a cheerleader for free market capitalism, but has many Democratic friends and is open to a good argument. We have seen him change his mind right on air, and he admits when he has been wrong. He is also as capable of beating up conservatives as he is liberals.

Kudlow & co. is stimulating and refreshing, and I highly recommend taping it at its new time. It gets a little over the top at times but there is always more light than heat by the end of the show.

Monday, October 08, 2007

AEI's Kevin Hassett (who will be joining us on tonight's Kudlow & Company) has a very good piece on Hillary over at Bloomberg. Here's a snippet.

"...There is an underappreciated angle to the story of how lawmakers steer federal funds toward their pet projects that may yet swing the next presidential election. Democrats have been so busy preparing the coronation of Hillary Clinton that they have failed to train a critical eye on her record.

When it comes to earmarks, an issue that voters responded to more than any other in the last election except for Iraq, her record is about as bad as it gets. If Dennis Hastert was the king of earmarks, Hillary Clinton was his queen. Republicans had their ``bridge to nowhere.'' Hillary has her knitting mill.

...Clinton, according to Taxpayers for Common Sense, placed $2.2 billion worth of earmarks in spending bills from 2002-2006. One would have to concede that she is good at it. In the fiscal 2008 defense-spending bill alone, Clinton successfully attached 26 earmarks worth $148 million, which was the most of any Democrat except Senator Carl Levin of Michigan, who is now chairman of the Armed Services Committee...That probably explains why she's trying to bury her record...."

Frank Newport, Gallup Poll editor-in-chief will shed some light on what the latest poll data is saying.

Joining in the discussion:

*Steve Moore, member of The Wall Street Journal's editorial board*Jared Bernstein, senior economist at the Economic Policy Institute*Kevin Hassett, director of economic policy studies at the American Enterprise Institute

GOP DEBATE PREVIEW...CNBC chief Washington correspondent John Harwood will join us live from Dearborn, MI with a preview of tomorrow night's debate. Subjects will include feuding between the Giuliani & Romney camps; who the real supply-side, fiscal conservative is; and Hillary's economic plan.

Kudlow has his eye on Matthews for Tuesday’s CNBC debate October 8, 1:34 AM

Softer ‘Hardball’?

After Yeas & Nays brought you the story of some pointed political remarks by MSNBC’s Chris Matthews on Thursday night, there’s been plenty of fallout, including some questions being raised about Matthews’ moderating of Tuesday’s GOP debate in Detroit.

The debate will be broadcast on CNBC, so we decided to ask CNBC’s Larry Kudlow for his thoughts on Matthews’ comments.

“It was a stupid, stupid thing to say,” said Kudlow, responding to Matthews’ comment that the Bush administration has “finally been caught in their own criminality.” Kudlow acknowledged Matthews was a friend of his but said, “He can go off the deep end at times.”

As for Matthews’ moderating Tuesday’s debate, Kudlow said, “I hope he will be on his best behavior.” Otherwise, Kudlow, who hosts the post-debate show on CNBC, said, “I’ll rap him very, very hard.”

When Yeas & Nays asked Vice President Dick Cheney’s office for comment, we simply were told, “We wish Chris good luck with his book.”

Friday, October 05, 2007

In politics and on the campaign trail, flip-flops can be very damaging. But Ben Bernanke’s whopper of a policy flip-flop two months ago turned out to be a big positive for financial markets and the economy, and may even help reverse the sinking fortunes of the GOP.

The flip-flop itself is a tale of two Bernanke’s: On the afternoon of August 7, the Federal Reserve chair was an inflation hawk — according to the unchanged FOMC policy statement — fearful of adding liquidity to the markets. By day’s end on August 9, however, he was leading the liquidity charge, initiating a process that would help unlock the credit seize-up that started in late-July.

Why the 180?

Using the Freedom of Information Act, Ken Thomas, researcher and lecturer at the University of Pennsylvania’s Wharton school, was able to get Bernanke’s calendar of phone calls and meetings at the time the flip-flop occurred. He found that a day after the Fed’s August 7 decision to keep rates steady and maintain a focus on inflation worries, Bernanke received a phone call from Citigroup’s Robert Rubin, the Wall Street powerhouse and former Clinton Treasury secretary. Thomas does not know the content of the Rubin call, but subsequent calls and events suggest that Bernanke rapidly changed his mind on August 8 and 9, after which he began steering the Fed towards a series of massive money additions to the banking system.

According to the Bernanke logs, a 5 p.m. Rubin call on August 8 was followed by a 7:30 a.m. next-day breakfast with Bush Treasury man Henry Paulson and an 11 a.m. meeting with legendary mortgage expert Lou Ranieri. (It was Ranieri who pioneered mortgage-backed securitizations, the very bonds that were collapsing as a result of the subprime mortgage virus that had already begun infecting the financial system.) At 2 p.m. that day the Fed chair met with Ray Dalio, head of Bridgewater, the fourth-largest U.S. hedge fund, along with other hedge-fund magnates. At 4:30 p.m., Bernanke was on a conference call with his fellow FOMC members, undoubtedly to discuss a Fed change of heart.

In fact, over the next few weeks, Bernanke participated in no fewer than thirty-five separate conference calls with fellow Fed operatives — a complete departure from his earlier no-conference-call style. And he got the liquidity ball rolling. As we now know, the Fed started pouring liquidity into the system on August 9. Then, on August 17, it slashed its base discount rate for member-bank loans by 50 basis points. Finally, on September 18, it enacted a shock-and-awe liquidity-adding half-point drop in the federal funds rate.

The Bernanke narrative is based on the incidence of calls and meetings, and not the actual content. But it seems clear that Rubin started a chain reaction on August 8 — only one day after the Fed’s disappointing, hold-the line policy decision that so disappointed financial markets and intensified the credit turmoil. Essentially, the academic Bernanke became a hands-on market participant through his contacts with Rubin, Paulson, the hedgies, and others. He reached out to savvy financial-market players who put him in touch with the real world. He then embarked on a 5-week journey that shook world credit markets out of their financial panic and started the healing process that continues to this day.

Financial confidence has improved, the credit crunch has loosened, and stock markets worldwide have rebounded dramatically, with the Dow hovering near its high of 14,000. This wipes the 2008 recession scenario off the table. For example, the latest jobs report shows 110,000 new payrolls for September, with the prior two months revised up by 118,000.

In the annals of flip-flops, the Bernanke switch is as good as they come. And not only economically, but politically.

Most pundits believe a prolonged economic downturn would doom any Republican in the presidential race against Sen. Hillary Clinton, the most likely Democratic candidate. The pay-to-play Intrade prediction market puts a 60 percent probability on a Democratic presidential win. Compounding this, a Wall Street Journal poll gives Democrats a 25 percentage-point advantage on cutting budget deficits, a 16 point margin on spending control, a 15 point lead on the economy, and a 9 point advantage on taxes. On top of that, the poll shows a serious Republican loss of business support.

Undoubtedly, an economic recession on top of all this would be gut-wrenching for the GOP. But Bernanke’s major-league monetary makeover, one that re-launched a pro-growth Fed policy to supply ample credit for economic expansion, changes all that.

It would be ironic if Clinton advisor Robert Rubin’s phone call to the Fed chief — a call that triggered a complete monetary about face — wound up bolstering the economy and keeping GOP presidential hopes alive.

Today’s solid jobs report gain of 110,000 for September, and 118,000 upward revision to the prior two months blows recession off the table. Particularly encouraging is the 463,000 gain in household employment. It sets up a Goldilocks stock market rally that could add another 1000 points to the Dow over the next six months.

Fed bigwig Donald Kohn strongly hinted a dollar protection program that rules out additional Fed rate cuts for the time being. I agree with Kohn. The Fed’s shock and awe 50 basis point rate cut in September has caused a loosening in the credit market freeze-up and provided a liquidity cushion for the entire economy. The Fed has done its job.

With inflation indexes running about 2 percent, domestic price stability is on course. Housing woes will take a percent off GDP for the next several quarters, leaving about 2 percent growth and 2 percent inflation. It is the quintessential Goldilocks soft landing scenario.

The Treasury yield curve has normalized in response to the added liquidity. Over the months ahead the credit market backup will continue to work itself out.

Another point: The added liquidity from the Fed will breathe new life into President Bush’s supply-side tax cuts which had been smothered over the last eighteen months by overly tight monetary policy.

Corporate profits will be flat in the third quarter just ended, but should normalize around 5 or 6 percent growth after that. With the 10-year Treasury hovering just over 4.5 percent, expected capitalized profits will keep the markets humming along.

Europe is probably moving toward a rate cut as they work through their own credit crunch. Interest rate differentials will lend strength to the greenback and take the froth out of the gold price. Essentially, the Fed has relaunched a pro-growth policy of adequate credit availability to accommodate low marginal tax rates.

Hopefully President Bush will continue his rebranding of the GOP as the new budget warrior and supply-sider-in-chief and prompt GOP candidates to make sharp contrasts with Sen. Clinton and the other Democrats over low taxes and limited government.

A 2008 recession would have been devastating for the Republicans. Now, as Goldilocks moves ahead, they have a fresh, new opening to relaunch their fiscal message and make the case to the investor class and the rest of the voting public that they can be trusted stewards of lasting growth and prosperity.

Thursday, October 04, 2007

In politics -- especially on the campaign trail -- key issue flip-flops are usually quite damaging. That’s not necessarily the case in monetary policy. Fed head Ben Bernanke had a whopper of a flip-flop nearly two months ago. But it was a very positive flip-flop for financial markets, the economy, and maybe even the sinking fortunes of the Republican Party.

Earlier this week, Wharton school finance lecturer Ken Thomas shed some light on the Fed chair’s flip-flop. Using the Freedom of Information Act, Thomas was able to unearth Bernanke’s calendar of phone calls and meetings during the height of this summer’s credit seize-up. By piecing together a logical narrative, he discovered that a day after the Fed’s August 7th decision to keep rates steady, and maintain their focus on inflation worries, Mr. Bernanke received a phone call from Wall Street powerhouse and former Clinton Treasury Secretary, Citigroup’s Robert Rubin.

Markets were already in disarray from the credit seize-up that started in mid-July. And while Thomas does not know the actual content of the Rubin call, subsequent calls and events strongly suggest that Bernanke rapidly changed his mind and steered the Fed towards a series of massive money additions to the banking system and a half point discount rate cut. All of which led to a shock and awe, liquidity-adding 50 basis point drop in the Fed funds rate on September 18th.

According to the Bernanke logs, the 5pm Rubin call on August 8th was followed by a 7:30am next day breakfast with Bush Treasury man Henry Paulson, and an 11am meeting with legendary mortgage expert Lou Ranieri. (Ranieri pioneered mortgage backed securitizations, the very bonds that were collapsing as a result of the subprime mortgage virus that had already begun infecting the financial system.)

At 2pm later that same day, the Fed chair also met with Ray Dalio, head of Bridgewater, the 4th largest US hedge fund, as well as other hedge fund magnates. At 4:30pm, Mr. Bernanke was on a conference call with his fellow FOMC members, undoubtedly to discuss a 180-degree Fed change of heart.

In fact, over the next few weeks, Bernanke participated in no fewer than thirty-five separate conference calls with fellow Fed operatives -- a complete departure from the chairman’s earlier style of not having conference calls.

As we know now, the Fed started pouring in new liquidity Friday August 10th with a major announcement. On August 17th they slashed their base discount rate for member bank loans by 50 basis points, and of course a month later, slashed their overnight target rate.

As Mr. Thomas notes, no one can be sure if this narrative is correct, simply because there is no available record of what was actually said during these calls and meetings. But it seems pretty clear that Robert Rubin started a chain reaction with his call back on August 8th. This was only one day after the Fed’s hold-the line policy decision that so disappointed financial markets and intensified the credit turmoil that many people feared would spillover into the economy and lead to recession.

Essentially, the academic Mr. Bernanke became a hands-on market participant through his contacts with Rubin, Paulson, the hedgies, and others. His learning curve efforts to reach out to savvy financial market players put him in touch with the real world. Basically, Bernanke embarked on a 5-week journey that shook world credit markets out of their financial panic and started the healing process that continues to progress right up to this very day.

Most folks would agree that while far from being completely solved, the credit crunch is easing. And of course, the stock markets have rebounded dramatically with the Dow hovering near its all-time 14,000 high. Stock markets all around the world have recovered. And the outlook for economic growth, though still uncertain, is nonetheless much brighter than it was back on August 7th when the Fed first turned its back on the emerging credit crisis.

Without question, Bernanke made a mistake in early August. But this is a case where his flip-flop was a very positive move, one that enhanced his credibility in U.S. and world markets.

About Me

Larry Kudlow

Lawrence Kudlow is CNBC’s Senior Contributor. For many years, he was the host of CNBC’s “The Kudlow Report”. He is also the host of The Larry Kudlow Show, which broadcasts on Saturdays from 10am to 1pm ET on WABC Radio and is syndicated nationally by Cumulus Media. He is also a nationally syndicated columnist and a former Reagan economic advisor. CNBC's The Kudlow Report also airs on Sirius (ch.129) and XM (ch.127) weeknights at 7pm ET.